Correlations Revive as China’s Slowdown Beats Rates

By Cecile Gutscher and Ari Altstedter  

Photographer: Sergio Dionisio/Bloomberg

Stackers operate next to stockpiles of iron ore at the processing facility at Fortescue... Read More

China’s deepening slump is re-establishing one of the oldest relationships in global markets: the link between currencies and commodities.
Shrinking demand from China for the raw materials of Australia, New Zealand and Canada is raising concern their economies will slow, weakening those nations’ dollars and outweighing the lure of their relatively high interest rates. Correlations that were lost around mid-year are being revived as currencies catch up with declines in everything from oil to dairy products.
“You can only resist gravity for so long,” Shahab Jalinoos, the head of global foreign-exchange strategy at Credit Suisse Group AG, said by phone from New York on Sept. 24. “For a while, you had a kind of tango between” rates and commodities, though “ultimately, the weak commodity price story is the driver,” he said.
Commodity currencies were supported earlier this
year by the loose monetary policies of the U.S. and euro region, which have pumped unprecedented amounts of cheap cash into the world economy and encouraged traders to invest where returns are higher. A slide in the Bloomberg Commodity Index (BCOM) this week to a five-year low means there’s little to support the Aussie, New Zealand kiwi and Canadian loonie.

Aussie, Iron

The 120-day correlation between Australia’s dollar and the price of iron ore became positive last week for the first time since April, and climbed yesterday to 0.4, a six-month high. That’s up from as low as minus 0.8 in July, a record in data compiled by Bloomberg going back to 2008.
A reading of minus 1 would mean they were moving in separate directions, while positive 1 would mean the assets moved in lockstep. Iron ore accounts for about half the economy of the mineral-rich state of Western Australia. The price when imported to China fell yesterday to a five-year low of $78.60 per dry metric ton.
Warnings this week about the pressures on China’s economy by Finance Minister Lou Jiwei vindicated Luc De La Durantaye at CIBC Asset Management Inc. in Montreal. He has short positions, or bets on a decline, for the Australian and New Zealand dollars, and increased his bearish wagers on the loonie in July.

‘Continued Correction’

“The market may still be in the process of revising their Chinese growth lower,” De La Durantaye, who oversees $15 billion of currencies, said by phone on Sept. 24. That points to “a correction in commodity prices and continued correction in commodity currencies,” he said.
The discovery by China’s currency regulator of almost $10 billion of fraudulent trades depressed commodity prices further yesterday amid speculation supplies may increase as stockpiles tied up in financing deals come back on the market.
China’s economy, the world’s second-largest, will grow 7.3 percent this year, according to the median forecast by analysts in a Bloomberg survey, the slowest pace in more than two decades and compared with the government’s target of 7.5 percent.
The reasons for the decline in commodity prices stretch beyond China. Oil demand globally is growing at its slowest since 2011, while the U.S. shale boom means production outside Organization of Petroleum Exporting Countries is rising by the most since the 1980s, the Paris-based International Energy Agency said this month.

Oil Link

The link between Norway’s krone and oil re-established itself in early August, after breaking down the prior month by the most since November. The correlation reached 0.6 yesterday, approaching the highest in 1 1/2 years, as the currency fell to a four-year low of 6.4641 per dollar on Sept. 18.
The relationship between oil and Canada’s dollar was turned on its head in March, with the correlation falling to as low as minus 0.6 the next month. Now they’re more in line, with the figure at 0.6.
Speculation the Federal Reserve is moving closer to raising the U.S.’s near-zero main interest rate is also weighing on commodity currencies and helping to revive the correlations.
The Aussie and kiwi, named for the flightless bird on the NZ$1 coin, are the biggest losers the past month in a basket of nine major currencies tracked by Bloomberg Correlation-Weighted Indexes, tumbling 3 percent and 2.4 percent.

‘World’s Locomotive’

A boost to U.S. borrowing costs would erode the appeal of the two nations’ assets, which is based upon them having the highest benchmark interest rates in the developed world.
Even so, commodity prices are more important to these currencies, according to Steven Englander, the New York-based head of Group of 10 foreign-exchange strategy at Citigroup Inc., the market’s biggest trader.
“The commodities move is too big to ignore,” Englander said by phone on Sept. 24. “It’s one thing, if it’s a moderate move, to say the central banks are a bit hawkish, it’s not going to be a big deal. It’s another thing if you see the world’s main locomotive of commodity purchases really slowing down in domestic demand.”
The kiwi touched a more than one-year low of 78.87 U.S. cents today, before trading at 79.11 at 11:12 a.m. in London, on course for its worst month since May 2013. Its slide has set the currency back on the same course as dairy products, New Zealand’s biggest exports, which have plunged 33 percent this year. That’s the biggest annual loss in data compiled by Bloomberg going back to 1986.
The Aussie and kiwi, like the loonie, have lost their appeal for Steve Lee, head of the foreign-exchange group at Nuveen Asset Management LLC in Chicago. He said that he reduced bets on gains in the Australian and New Zealand currencies at the end of the second quarter, and began shorting Canada’s dollar in the third.
The rates story “was very attractive, and that attracted inflows into Australia and New Zealand,” Lee said by phone on Sept. 24. “More recently things have changed. Those currencies are more vulnerable than before.”